(Bloomberg) — US Treasuries rallied, led by shorter-dated notes, as investors assessed the likelihood of a half percentage point Federal Reserve interest-rate cut next week.
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Yields on policy-sensitive two-year notes dropped five basis points to 3.59% in Asian trading on Friday, while those on 10-year debt fell three basis points to 3.65%. The dollar slipped as a result, providing a boost for major currencies.
The Fed is expected to lower its key rate for the first time in more than four years once it concludes its two-day meeting on Wednesday. Traders conflicted over whether the central bank will go for a 25 basis point rate cut or a 50 basis point reduction have stared leaning toward the latter, with Fed officials in a blackout period before the policy meeting.
“Renewed speculation that the Fed could possibly deliver a 50 basis point cut at next week’s meeting is driving this US Treasury bid,” said Prashant Newnaha, a senior Asia Pacific rates strategist at TD Securities in Singapore. “The Fed could arguably deliver a larger 50 basis point cut citing fed funds being well above the bank’s estimate of neutral.”
Overnight-indexed swaps priced in a 33% chance of a 50 basis point reduction in the federal-funds rate. The odds have increased since a Wall Street Journal report said Fed policymakers were considering whether to cut by quarter or half a percentage point.
“This morning’s WSJ article has reignited the debate about whether the Fed could begin its easing cycle with a 50 basis points cut,” said Damien McColough, head of rates strategy at Westpac Banking Corp. “Given the Fed is in blackout ahead of the FOMC, the market has placed great weight on the article’s messaging.”
Former New York Fed President William Dudley’s comments reaffirmed traders’ stance. He said “there’s a strong case” for a larger-than-usual reduction. Dudley left the New York Fed in 2018 and is now chair of the Bretton Woods Committee and a Bloomberg Opinion columnist.
A Fed rate cut next week is all bur certain as the central bank’s favored gauge of inflation has retreated near its longer-term target of 2% from a high of over 7% two years ago. Disappointing US data including a surprise drop in jobs openings have also supported the case for rate cuts.
“If the Fed delivers a 50 basis point cut, the market is unlikely to view it as a one and done, and it will anticipate a follow up 50 basis point cut,” Newnaha said, adding that in this scenario, “expect a sharp drop in yields.”
The Bloomberg Dollar Spot Index slipped 0.2%, boosting currencies like the Thai baht and South Korean by more than 1% each.
(Updates with additional chart and analyst comment in 6th paragraph.)
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